On Our Radar

Tax Reform and Your Small Business

Every couple of years utterances of the implementation of a flat tax emerge. In fact, in a tax seminar during the early 1990s, a well-revered speaker made one of those mark-my-words predictions that the flat tax would be operational within the next few years.

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Twenty four years later, there’s no flat tax. In fact, our tax law has become even more complex and convoluted.

When President Obama entered the White House in 2008, promises were again made that the tax code would receive a major overhaul. But other issues were bold-faced over this promise: the fiscal cliff, sequestration, wars, ObamaCare (which created even more complexity in the tax arena) and who can forget, a government shutdown. As usual, tax reform sits on a back burner. The last major tax reform took place in 1986 under Ronald Reagan. Many economists agree that restructuring created more jobs, something our current day economic recovery is still lacking. Small business owners would love nothing more than than to have to hire more employees. That would mean business is booming and sales are up.

In 2010, a presidential commission came forward with some ideas for tax reform. Their proposals have been an area of study by the American Council for Capital Formation (ACCF), which added improvements to the commission’s recommendations. They have also studied recent congressional tax reform proposals such as those offered by former Senate Finance Committee Chairman Max Baucus, Sens. Ron Wyden and Dan Coats and by House Ways and Means Committee Chairman Dave Camp.

According to an ACCF Special Report, “These plans – share the basic architecture of the National Commission on Fiscal Responsibility (Bowles/ Simpson plan) examined here while lowering income tax rates on business they also eliminate provisions important to many industries. These eliminated provisions include accelerated depreciation, the domestic production deduction (Section 199), LIFO and others.”

Treasury staffer Robert Carroll and accounting giant Ernst and Young have created the Growth and Investment Tax (GIT) which builds on the Simplified Income Tax Plan and would provide incentives for every industry, not just a few.

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The GIT proposal includes two valuable provisions for all businesses. One is the ability to write off the entire cost of all capital asset purchases, no matter how large. Depreciation would be a thing of the past. The other is aimed for retail operations – the current write off of all inventory purchases. Presently, retail concerns must capitalize the cost of inventory and only enjoy the deduction when the goods are sold. Otherwise inventory sits on the balance sheet not offering a tax advantage to the business owner despite the expense incurred. The ability to deduct just these two expenses will reignite businesses’ desire to expand and spend money.

Margo Thorning, the chief economist and senior vice president of the ACCF, says tax reform is still several years away. “I don’t think it’s Obama’s priority. But if the GIT plan were implemented, we will see enough new investment to grow the economy.”

She adds, “Given the vital importance of new investment to our nation’s economic outlook – $1 billion in new investment has been associated with the creation of 20,000 new jobs over the last three decades – this is a fact that today’s tax writers must closely consider as they weigh the impact of their proposals on the ability of capital intensive industries to create job and support the gross domestic product.”

The GIT plan contains many provisions to help a small business thrive. As previously stated, the depreciation deduction, bonus depreciation, Section 179 expensing would completely disappear. Rather than writing off the cost of capital assets over their useful lives, businesses would be allowed to write them off in the year of acquisition regardless of cost. One caveat: Interest expense would no longer be deductible. This will encourage business owners to pay cash whenever possible rather than finance the asset.

Section 179 allows the current deduction of capital asset purchases. And the limits in the past have been fairly generous - up to $500,000 - unless your business requires greater expenditures. And business owners are allowed to expense the interest they pay on borrowed funds to finance the capital expenditures. But this year, the Section 179 threshold is set to $25,000 unless it will be changed when Congress gets around to reviewing that and the other 55 expiring extenders. The interest expense deduction would be phased out unless the business was a financial institution.

Presently, small business owners must deal with more paperwork and bean counting to comply with tax law in the area of inventory. The GIT proposal would eliminate the necessity of this additional time-consuming work. Inventory control would still be important if GIF was enacted, but the extra accounting work required for tax purposes would be eliminated.

The economy would grow more strongly if business was allowed to expense new equipment. Finally, the ACCF Special Report states, “Understanding the impact of potential tax reform proposals on investment incentives – both on the overall level of tax on the marginal investment and the variation across investment types – is an important step to gauging their potential economic impacts.”